Tax-aware long-short strategies have attracted more than $170 billion in assets from wealthy investors, up from just $2 billion in 2022, according to Tax Alpha Insider, as high-net-worth individuals search for ways to shelter large stock market gains from capital gains tax. For context, TaxProf Blog estimates that millionaires have poured roughly $150 billion into these products in just three years.
So what exactly are these strategies? A tax-aware long-short strategy, often abbreviated to TALS, tracks a stock market index while simultaneously making leveraged bets (some positions held long, others sold short) in order to generate capital losses that can be used to offset taxable gains elsewhere in a portfolio. The result, proponents argue, is a way to stay invested in the market while reducing the tax bill that comes with it.
Why Wealthy Investors Are Rushing Into TALS
Three consecutive years of double-digit stock market gains have left many high-net-worth investors holding large unrealised profits they would rather not crystallise for tax purposes. Business owners who have sold companies, executives with concentrated shareholdings, and employees who received stock that rose sharply after an initial public offering are all turning to TALS products to absorb those gains.
Bob Casey, chief executive of Santa Barbara Management, which advises family offices, explained the potential benefit with a straightforward example. A $1 million portfolio running a tax-aware long-short strategy could generate capital losses of $250,000 in the first year. For an investor based in California who is offsetting short-term capital gains, Casey said those losses could be worth up to $137,500. “These are phenomenally profitable and sticky products that the wealth management industry is incentivised to sell,” he said. “They are growing at eye-popping rates.”
Academic researchers have also been examining how these products work in practice. A study titled ‘Loss Harvesting or Gain Deferral? A Surprising Source of Tax Benefits of Tax-Aware Long-Short Strategies’, published in the Summer 2024 issue of The Journal of Wealth Management, constructed two types of 250/150 long-short strategies (one tax-aware and one tax-agnostic) to compare outcomes. Alpha Architect covered the study, and its findings add nuance to the marketing claims often made for TALS products: the tax benefits may owe as much to gain deferral as to outright loss harvesting.
The Four Risks Investors in Tax-Aware Long-Short Strategies Need to Understand
Despite the appeal, tax attorneys and investment experts warn that too many wealthy investors are buying into TALS without understanding the full picture. Four risks stand out.
First, there is regulatory scrutiny. Earlier this summer, Treasury officials speaking at a Wall Street Tax Association seminar warned of “aggressive planning” involving investment products that generate tax losses. They did not name tax-aware long-short strategies by name, but cited comparable products. “We’re not going to let sophisticated abusive tax structuring become a runaway train,” one official said, according to two people who attended the seminar. Mohsen Ghazi, partner at Ashurst Perkins Coie, said Treasury appeared to be signalling it would “use the different tools at their disposal.” Vivek Chandrasekhar, also a partner at Ashurst Perkins Coie, advised potential investors to “just be a little bit more cautious.”
Second, these strategies function more as tax deferrals than outright tax savings. Exiting a TALS position is far harder than entering one. Unwinding the leveraged positions means previously unrealised gains can all become taxable at once. Christopher Houston, head of private wealth strategies and family office services at Cambridge Associates, put it plainly: “You can’t just say, ‘let’s turn this off.’ You could wind up back in the same place.”
Third, leverage creates real investment risk. The most common structures use a 130/30 ratio: for every $100 invested, $30 is borrowed for additional long positions and $30 for short positions. Some products go to 150/50 or beyond. “Leverage can make fortunes and leverage can end fortunes,” Houston said.
Fourth, there is the question of fees and underperformance. TALS fees run between 1% and 3% of the entire portfolio, covering management, financing and borrowing costs. Financing spreads have widened over the past year as lenders demand more compensation for risk. On top of that, leverage can increase “tracking error”, the gap between a portfolio’s returns and the index it is meant to follow. “If you run this strategy long enough, you should reasonably expect to experience periods in which your portfolio materially underperforms the index on a pre-tax basis,” Casey said.
Houston’s conclusion is perhaps the most practical guide for any investor weighing up a TALS product: “Tax deferral can have a true economic benefit. But you have to know what your endgame is.”
